The Stock Exchange of Hong Kong (the Exchange) has published a Concept Paper on Weighted Voting Rights (Concept Paper) seeking views on whether companies with governance structures giving certain persons voting power or other related rights disproportionate to their shareholdings (weighted voting right or WVR structures), should be allowed to list on the Exchange’s markets.
Published on 29 August 2014, the Concept Paper comes as Chinese e-commerce behemoth, Alibaba Group, celebrates its record-breaking IPO on the New York Stock Exchange (the NYSE): raising US$ 25 billion, the IPO turned down by Hong Kong’s Stock Exchange, ranks as the world’s biggest IPO ever. The Hong Kong Exchange has long been the international market of choice for listing Mainland Chinese companies, and it was in fact the initial front-runner for the Alibaba IPO. However, it refused the group’s IPO on the Exchange’s Main Board because the group’s structure gives a group of founding shareholders the right to appoint a majority of the company’s board, which would have contravened the one share one vote principle in Hong Kong.
WVR structures are however allowed in the United States, where companies using them account for approximately 14% by market capitalisation of all large cap companies and include Google, Facebook, Visa and Mastercard. Hong Kong has long been the leading international financial centre for listing and trading Mainland Chinese companies which account for 57% of the Exchange’s total market capitalisation and 70% of equity turnover. However, Mainland Chinese companies are increasingly opting for a US listing (on NYSE or NASDAQ): as at 31 May 2014, 102 Mainland Chinese companies were primary listed in the US. Around 29% of those companies have a WVR structure and together, they account for 70% of the market capitalisation of all US-listed Mainland Chinese companies. 70% of the US-listed companies with WVR structures are information technology companies. As a result, some of China’s most competitive and popular companies are part of the NASDAQ Composite, but are not in either the MSCI China or Hang Seng China Enterprises indexes, two of the most commonly tracked benchmarks of Mainland China stocks. In contrast, information technology companies make up only 7% of the total market capitalisation of all Hong Kong listed companies. Only two information technology companies (Tencent Holdings Limited and Lenovo Group Limited) are included in the 50 constituents of the Hang Seng Index. The largest industries by market capitalisation on the Exchange are financials and properties and construction.
The Concept Paper states that the Exchange is neither for nor against WVR. Its intention in publishing the Concept Paper is to set out the relevant issues and considerations in a neutral, factual and analytical manner in order to promote a focused discussion on whether companies with WVR should be allowed to list. If responses to the Concept Paper show support for listing companies with WVR structures, the Exchange will publish conclusions explaining the reasons given and would then conduct a further formal consultation on the details of the scope and language of the necessary Listing Rule amendments. Responses to the Concept Paper should be made by submitting the completed Questionnaire on Weighted Voting Rights to the Exchange on or before 30 November 2014.
The following provides a summary of the issues raised in the Concept Paper.
1. Current Hong Kong Position
1.1 Current Rules and Principles
The fair and equal treatment of all shareholders is a fundamental principle of Hong Kong’s Listing Rules. Main Board Rule 2.03(4) (GEM Rule 2.06(4)) provides that: “The Listing Rules reflect currently acceptable standards in the market place and are designed to ensure that investors have and can maintain confidence in the market and in particular that:- …. All holders of listed securities are treated fairly and equally”.
Companies are prohibited from listing if the voting power attached to their shares does not bear a reasonable relationship to the equity interest of those shares. The prohibition also applies after listing. As a result, companies with multiple voting shares, inferior par value shares and non-voting ordinary shares cannot be listed in Hong Kong. The prohibition is set out in Main Board Rule 8.11 (GEM Rule 11.25) which states that:
“the share capital of a new applicant must not include shares of which the proposed voting power does not bear a reasonable relationship to the equity interest of such shares when fully paid (“B Shares”). The Exchange will not be prepared to list any new B Shares issued by a listed issuer nor to allow any new B Shares to be issued by a listed issuer (whether or not listing for such shares is to be sought on the Exchange or any other stock exchange) except:
(1) in exceptional circumstances agreed with the Exchange; or …”
Although this Listing Rule refers to “voting power”, the Exchange states in the Concept Paper3 that it interprets the Rule as prohibiting all WVR structures, including those that give enhanced or exclusive director election rights. The Rule would thus disqualify from listing eligibility a company which achieved the same effect by embedding such rights in the company’s articles rather than by creating two classes of shares.
1.2 Genesis of the Prohibition on WVR Structures
Listing Rule 8.11 was introduced in 1989 in response to a 3.7% fall in the Hang Seng Index in March 1987, which was triggered by announcements by three listed companies of their intention to offer B shares via bonus issues. As part of fund raising exercises in the 1970s, the companies had issued B shares which had equal voting power to the companies’ existing A shares, but had a lower par value, and thus a lower dividend entitlement, than the A shares. B shares were typically entitled to either a fifth or a tenth of A share dividends and thus traded at lower prices. The B share issuers claimed that the issues were intended to fund real estate purchases and business expansions.
After the fall in the Hang Seng, the Standing Committee on Company Law Reform published a report on WVR structures in July 1987. The report concluded that the reason for issuing B shares was to allow companies controlled by founding families or entrepreneurs to retain control, while still being able to raise equity finance. They also provided an inexpensive way for controllers to purchase voting power and consolidate control, since they carried one vote per share but traded at a discount to A shares because of their lower dividend entitlement. The Standing Committee report also noted that in the context of Hong Kong’s 1997 return to Chinese sovereignty, B shares enabled a majority owner to transfer substantial portions of its capital overseas while maintaining actual control in Hong Kong. This could be achieved by a majority shareholder selling A shares, and at the same time purchasing B shares in equal proportion. The Standing Committee feared that the practice could lead to “a lessening of confidence in Hong Kong as a major financial centre” which was why it opposed the indiscriminate issue of B shares.
Nevertheless, the Standing Committee considered that there remained a legitimate need for the continuing availability of B shares in exceptional circumstances. Examples of such “exceptional circumstances” stated in the report included where “national security or the interests of the community as a whole ….may make it desirable that ultimate control should be concentrated in particular hands, although there is support for the view that the use of B shares for these purposes is normally only acceptable when a company first applies for a listing and there is no question of protection for minority shareholders”.4 As a result, Listing Rule 8.11 was introduced to prohibit the listing of companies where voting power and equity interest are not aligned, but allows the Exchange to approve the listing of such companies on a case-by-case basis in exceptional circumstances. The Exchange has not permitted any company to list in reliance on the exception to date.
1 US headquartered companies primary listed on NYSE or NASDAQ with a market capitalisation greater than US$2 billion.
2 HKEx data as at the end of July 2014.
3 Concept Paper at paragraph 82.
4 The Third Interim Report of the Standing Committee on Company Law Reform: B Shares (July 1987) at paragraphs 8 and 12. An extract from that report (including the relevant paragraphs) is included in the Concept Paper at Appendix 1.